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Legg Mason (NYSE:LM)

F2Q2011 Earnings Call

October 26, 2010 5:00 pm ET

Executives

Alan Magleby - Director of IR

Mark Fetting - Chairman and CEO

Terrence Murphy - Interim CFO

Joseph A. Sullivan - Sr. EVP and CAO:

Analysts

Dan Fannon - Jefferies

Michael Kim - Sandler O' Neil

Michael Carrier - Deutsche Bank

William Katz - Citi

Roger Freeman - Barclays Capital

Craig Siegenthaler - Credit Suisse

Brennan Hawken - Collins Stewart

Glenn Schorr - Nomura

Marc Irizarry - Goldman Sachs

Cynthia Mayer - Bank of America/Merrill Lynch

Macrae Sykes - Gabelli & Company

Douglas Sipkin - Ticonderoga

Jonathan Casteleyn - Susquehanna

Operator

Good morning and welcome to the Legg Mason's Second Quarter Fiscal Year 2011 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions). Please note this event is being recorded.

I would now like to turn the conference over to Alan Magleby, Director of Investor Relations. Please go ahead, sir.

Alan Magleby

Thank you. On behalf of Legg Mason, I would like to welcome you to our conference call to discuss operating results for the fiscal 2011 second quarter ended September 30, 2010.

This presentation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not statements of facts or guarantees of future performance, and are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those discussed in the statements.

For a discussion of these risks and uncertainties, please see Risk Factors and Management's Discussion and Analysis of Financial Conditions and Results of Operations in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2010, and in the company's quarterly reports on Form 10-Q.

This morning's call will include remarks from the following speakers, Mr. Mark Fetting, Chairman and CEO; and Mr. Terrence Murphy, Legg Mason's Interim CFO, who will discuss Legg Mason's financial results. In addition, following the review of the company's quarter, we will then open the call to Q&A.

Now, I would like to turn this call over to Mr. Mark Fetting. Mark?

Mark Fetting

Thank you, Allen. Good morning to all and thank you for your interest in Legg Mason. Today, we will walk you through our results for our second fiscal quarter. Legg Mason delivered improvement in net income the best since of '07 and the highest operating margin as adjusted since September of '08. I believe these results are rooted in our turnaround priorities and progress while also helped by improving markets. We will give you more color throughout the deck.

After a volatile summer in the equity markets the S&P 500 had its best September performance since 1939 and stocks continue to trend upward in October as strong earnings growth offsets uncertainty in global currency markets.

In the bond markets, we have weathered a potential European financial crisis, fears concerning China and a broader Asian slowdown and threats of a US double dip. Our fixed income managers at Western continue to believe that the economic recovery will be durable though not robust. They continue to believe that central banks can successfully manage deleveraging and fiscal retrenchment. Inflation should not be an issue over the medium term though they will be carefully monitoring the effects of actions being taken.

The employment picture, which is perhaps the most important factor in a sustained recovery, continues to be mixed. Nonetheless, we remain reasonably confident that the US can avoid a double dip recession. Quality companies continue to look very attractive to our managers across the spectrum of market caps on a valuation basis.

Clearly, investors continue to remain cautious. During the quarter, I visited our clients in Asia including major sovereign wealth funds. Across our managers we have strong position here and are growing well. It is interesting to note that they like all investors, retail and institutional, are now preparing to grow and not just protect their portfolios. We have been working hard to be in a position to help them when they do.

Let us begin with the business developments in the quarter on slide 2. We delivered net income of $75 million or $0.50 a share and adjusted income of $1.15 million or $0.76 a share. Importantly, our financial metrics improve significantly year-over-year. Operating revenues were up 6%, adjusted income is up 19%, net income is up 29% and GAAP earnings per share is up 23%.

Across many of our affiliates investment performance continues to be strong and the streamlining of our business began on July 1, and is proceeding on track. We've continued our stock buyback program. We have now retired over 11 million shares over t past two quarters or about 7% of the shares outstanding as of the end of March. We announced today that the board increased the dividend of $0.06 a share reflecting the board's view of our improved earnings, cash generation and strong balance sheet.

Slide 3 shows graphically our streamlined business model. Our seven principal investment affiliates are the cornerstone of the model. Together we form a powerful multi-manager firm. Legg Mason's corporate focus is capital allocation including working with our affiliates to attract new investment talent and seed new products. With a strong balance sheet we are well positioned to do that.

Our distribution platforms are building compelling value. We believe the infrastructure is positioned to support substantially increased volumes. We believe that delivering client value will drive shareholder value.

Go to the next slide, we do our cut of assets under management which ended the quarter at $674 billion, up 4% from the prior quarter. Fixed income assets was $372 billion or 55% of the total; equity 170 or 25%; and liquidity 132 or 20%.

When cut by revenues, equities are at 42%, fixed income 36%, alternatives 14% and liquidity 8%. Strategically, as I have said before, we will seek balance across these revenue streams with added emphasis on alternatives and international equities.

Go to the next slide. We show our net flows. Fixed income outflows were down slightly to $8 billion, equity outflows were $4.4 billion and liquidity flows were virtually break even at $300 million out. About 60% of the total net outflows from Western in the fixed income side came from two main sources. The first is a global sovereign product that has seen money come out in this low rate environment though outflows from this mandate have been offset from a revenue perspective by inflows in higher P products. The second is a large sub-advisory account which has been winding down at Strategy over the past year. That wind down will be completed in the December quarter.

Equity outflows were $4.4 billion where retail and institutional fund activity was consistent with industry data. Permal has shown positive flows for two consecutive quarters.

Let us go to our review of managers, start with Western at $469 billion, up 3% from the June quarter driven by market appreciation partially offset by modestly lower long term outflows. Most important, improvements at Western continue across the board. While we acknowledge that flows are slower to recover outflows are their lowest level since December of '07. Other comparison like revenues, sales activity, performance and consultant ratings are very encouraging.

We continue to see a trend of money coming out of lower rate, lower fee products into more specialized and more profitable products. As expected, Western has seen the end of calendar year '10 as the beginning for a strong 2011. We will provide more color on Western a bit later.

Second is Permal, up 3% from the June quarter driven by market appreciation FX and positive flows. Performance continued to be strong across their product. Incentive fees for the quarter were approximately $8 million and about 80% of their eligible assets were above their high water mark at the end of September. Their institutional pipeline is strong with over $250 million unfunded wins and over $750 million in final presentations in the next six months. Redemption levels are stable at 1% of assets per month. They made a senior hire to focus on the US high net worth market and we are working with them on new product initiatives for the beginning of 2011.

ClearBridge, at approximately $51 billion, is up 9% from the June quarter. The rate of outflows has declined year-over-year. A partnership with ClearBridge in the international distribution space is showing momentum. ClearBridge received a $100 million mandate in the appreciation from a large bank and Portfolio Manager Scott Glasser will be headed to Europe to build on that success. To expand their presence in the institutional marketplace, ClearBridge has hired a senior sales and marketing professional who will build upon the work that they have done over the past four years to build a presence in that channel.

Royce, at $34 billion, is up 10% from the June quarter. In the quarter, Royce has modest outflows, however, for the fiscal year to date they have had inflows. Products that are focused on dividends and micro-cap are performing well. After the volatility in the summer investors have began to focus on risk and quality companies with strong balance sheets and above average returns on capital. Royce will launch four new products at the end of the year that will round out their international fund offering.

Legg Mason Capital Management has approximately $15.5 billion, up 5% from the June quarter. They have seen additional money in some of their existing clients and have launched the Disciplined Equity Research Fund within institutional share class. This is built off a research seed fund that was originally launched in '08, which has had strong performance.

We announced last week that Sam Peters will join Bill Miller as Co-Manager of Value Trust in November. Sam and Bill have worked together for more than five years and have co-managed several products successfully together.

Batterymarch ended the quarter at $22 billion, up 13% from the June quarter driven by appreciation and modest net outflows. Based on initial estimates, Batterymarch composite performance relative to its peers has improved across most mandates in the quarter and its markets have begun to broaden out particularly in September that should favor their quantitative strategy.

The emerging market product continues to attract investor attention with a robust pipeline of searches and several wins to fund in this quarter. Brandywine ended the quarter at just over $31 billion, up 7%. We have worked with the team at Brandywine to launch a Diversified Large Cap Fund. We are also working with its fixed income team to promote a Global Bond Fund within our Americas distribution channel.

Slide 7 updates you on our performance records. As you can see in aggregate our 3, 5 numbers continue to improve with our 10-year remaining strong.

Let's turn to the slide we prepared on Western. Western has moved from defense to offense. They are clearly spending more time on getting new business and bringing new assets in the door as opposed to playing defense with clients as performance numbers have grown stronger.

Net flows from long-term mutual funds US and international are positive fiscal year-to-date and include $1.2 billion of net positive flows in the month of September, a record level. Further, fiscal year-to-date, our net flows from the long-term mutual funds exceeds the results for the whole of fiscal year 2010.

Western has regained the confidence of the consultant community. A majority of the major consultants now have Western rated neutral to positive, a huge improvement from recent years, and the conversation gets better each and every day.

The pipeline for new business is strong and building robustly, but there are headwinds albeit declining ones. As I mentioned earlier, the majority of the outflows for the quarter are really down to two sources, one in sub-advisory mandate that will cease this quarter and the second a global sovereign product whose yield has become less attractive in this environment but is offset with some favorable inflows to other higher fee products.

We also point out that Western's outflows from lost clients in the September quarter were half the level of the June quarter and 70% below the December '09 quarter and inflows from new clients have not yet fully recovered, but fiscal year-to-date inflows are improving. The key here will be to pick up with the improvement in performance, the improvement in consultant ratings, to win more business and that will offset the declining, and in some cases, definitively ending outflows in certain segments.

As you can see, strong recent performance has positively affected longer term performance numbers. The amount of Western Institutional fund assets that are ranked four or five star by Morningstar have risen dramatically over the past year. It is important to note that Morningstar rankings incorporate risk management, so we believe this is reflective of the improvements in risk management procedures and reduce volatility in these funds. While it's hard to predict exactly when funds will go positive, we are confident that they are making progress on all important fronts.

Now shift to America's distribution. Net outflows for the quarter were $2.6 billion, reflecting lower sales partially offset by lower redemptions. The large insurance client we referenced has been unwinding, a mandate over the past year and this quarter it contributed $1.3 billion of outflow in the quarter we're reporting today. Approximately $400 million of this quarter's redemptions came from reallocation decisions from particular asset classes made by one of our distribution partners.

Looking at sales, the last quarter included the large MLP closed-end fund raise. Excluding that, our sales decline was inline with industry open-end funds and somewhat unfavorable in the SMA accounts space.

We continue to gain share in municipal bond fund sale. The Legg Mason Western Asset Managed Municipal Fund is the top fund in its category in net flows for the quarter ending 9/30 and year-to-date.

We have also won some business in several equity strategies. Yesterday, we successfully completed the raise of a new high-yield closed-end fund raising approximately $480 million, including the greenshoe. That fund will start trading today and we will put out a press release later this morning.

We continue to see diversification in our sales channels. The Independent Advisor Channel is now nearly a third of total retail sales and 61% of total retail sales now come from non-legacy firms. Our teams have launched 22 new products over the past four years with more than $4 billion in the top grossing funds.

Let's swift to International. Here you can see continued progress across the board. We posted our seventh straight quarter of positive net flows driven primarily by Japan in Europe. Year-to-date, there have been $4 billion in net inflows bringing the total AUM to $47.5 billion supported by the International team. Interest income continues to be driven by fixed income products particularly local currency products and global bond products. New funds are an important contributor with the top 10 grossing new products raising approximately $6.5 billion in assets over the past three years.

The next slide we have listed the success we have had working with our affiliates in new product launches. As you can see, they cut across a number of our affiliates and are domiciled in different regions around the world. They totaled nearly $10 billion in AUM underscoring that innovation can lead to strong growth.

Let me turn it over to Terrence Murphy.

Terrence Murphy

Thank you, Mark. As Mark noted earlier, in the second fiscal quarter of 2011, we achieved solid results in a quarter where equity markets recovered. Although average AUM was down from the prior quarter, revenue was up slightly and our operating margins as adjusted are the best we have reported since the September 2008 quarter.

With that, I will go through some more detail on the results on slides 12 and 13. Our net income was $75 million or $0.50 per diluted share, up from the prior quarter's net income of $48 million or $0.30 per diluted share. One of the contributors to the significant improvement in earnings this quarter is a special UK tax benefit of $8.9 million or $0.06 per diluted share that we highlighted in last quarter's 10-Q.

We also incurred nearly $12 million in transition related costs, which negatively impacted earnings this quarter. Although our average AUM was down 1% from the prior quarter, we generated slightly higher revenues due to an additional day in the quarter and decreased fee waivers on funds. Fee waivers this quarter were $4 million lower than the prior quarter. We also generated nearly $20 million in performance fees in fiscal Q2; slightly down from last quarter. Western, Permal and Brandywine contributed to the performance fees.

Operating expenses increased by 3% for the quarter. The increase was largely driven by significant gains of $22 million on funded deferred compensation and seed investments compared to a $5 million loss in the previous quarter. This line item is offset from other non-operating income, so there is no bottomline impact. In addition, we incurred close to $12 million in transition related cost associated with the streamlining effort. I'd also like to remind everyone that last quarter's expenses included the closed-end fund launch expense of $18 million related to the successful $1.3 billion ClearBridge Energy MLP Fund. Our adjusted income was $115 million or $0.76 per diluted share and our operating margin as adjusted was 24.1% for the quarter.

Let's turn to slide 13. I would like to highlight the effective tax rate. This quarter's rate was favorably impacted by the $8.9 million credit we recorded related to our reduction in the UK corporate tax rate. UK Finance Bill of 2010 will reduce the corporate UK rate from 28 to 27%. Excluding that item, our effective tax rate would have been 35% in line with our expectation.

Turning to slide 14, you will see that operating expenses increased by $16 million but the primary driver was the $27 million increase in gains on funded deferred compensation and seed investments. Excluding that gain expenses would have been 2% lower this quarter. This quarter's costs include $12 million in transition related costs while last quarter's expenses included the $18 million in costs related to the closed-end fund launch.

There was also an $8 million increase in other operating expenses this quarter. Approximately $3 million of these costs related to annual costs for promotional and governance activities and then there's also a $5 million increase related to operating losses and legal reserves, which are offset in comp and benefits line that had minimal impact on the Legg bottomline.

Turning to slide 15, when you exclude the transition cost of $12 million and the mark to market on the deferred compensation and seed investments, the comp to benefit ratio comes in at 51%. This is below our targeted range of 52% to 53% previously communicated. When you add back the $5 million related to the operating loss and the legal reserves, which are offset in comp and benefits the ratio comes in at 52%.

As both Mark and I have pointed out, our operating margin as adjusted at 24.1% is the highest result in two years and only minimally reflects the benefits of our streamlining efforts which are expected to add between 600 and 800 basis points to our operating margin when completed.

On slide 17, we are providing some additional color around the share authorization and the accelerated share repurchase we announced last quarter. On September 30, 11.4 million shares have been repurchased including the previously announced 500,000 open market share repurchase in May and the 9.2 million related to ASR back in June. When we closed out the ASR in August we were able to reduce our share count by an additional 1 million shares and we took advantage of the [fresh] share price in August and September and repurchased an additional 736,000 shares.

So, in total, we have 664 million remaining of the 1 billion authorization to repurchase additional shares and we are planning to purchase up to $80 million worth of additional shares by fiscal 2011 year-end.

As Mark indicated earlier, we are making solid progress on the transition of services to our affiliates. The majority of these shared services that we are transferring, our affiliates have completed their assessments and selected new service providers. Implementation planning is now underway with these providers in some areas we have already begun the transition process.

We are still targeting $130 million to $150 million of savings and we expect to incur about $130 million in restructuring charges. To date we have incurred about $15 million and we are expected to incur approximately $15 million in additional charges in the fiscal third quarter. Our expectation continues to be that by 4Q 2012 our expenses will be reduced by 2012 our expenses will be reduced by $140 million per year on a run rate basis.

With that, I will turn it back over to Mark for additional comments.

Mark Fetting

Thanks, Terrence. If you step back and you look at the progress we've made on balance sheet and earnings, it's formidable. We now want to turn our attention and you should know affiliates and Legg Mason together are focused on growth, which should be measured in improved flows, whether that's in the equity area, the fixed income area, or alternatives where we're already in positive flows.

If you look at the final slide, we are going to focus on our strategic priorities partnering with our affiliates for franchise expansion and growth. Across many of our affiliates, investment performances continued to be strong. We also want to enhance that growth through product development. That's been a key focus, as you can see from the updates we've provided. We're streamlining our business model and we're on track to achieve our targets, and we are effectively deploying our capital from our strong cash generation position.

I want to thank you and open it up for questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions). Our first question comes from Dan Fannon of Jefferies. Please go ahead.

Dan Fannon - Jefferies

Mark, the stats you gave around Western, I guess a few points of clarification. You mentioned long-term mutual funds being positive in September in terms of flows. In terms of total assets, does this segment represent?

Mark Fetting

What you'd have to do is combine the funds in the US and the international funds because that's a combined category. I'm going to say roughly in assets Western, it's probably somewhere in the neighborhood of 30%, 35% of their assets and a bit more of their fees because of course the fees on those funds tend to be higher than on the institutional accounts.

Dan Fannon - Jefferies

As you think about the momentum there and then as we head into the calendar year end, do you anticipate any potential pick up in either redemption activity or just move in either sales also, just based on the year end or calendar year effect in terms of potential replacements of firings or hiring that type of action?

Mark Fetting

That's always been a busy quarter. At this stage, the seasonality probably gets trumped by just the momentum that's occurring. What we try to do is isolate the improvement that's already being achieved in the retail sector with this update on, what I will call, the global fund results and give a little more color around the institutional side where you see a number of areas as we referenced is getting inflows, but still some of these headwind areas whether it's certain products that are just not as in favor as they've been. That kind of improvement of consultants will probably outweigh the traditional seasonality factor but it will still be there a bit.

Operator

Our next question comes from Michael Kim of Sandler O' Neil.

Michael Kim - Sandler O' Neil

First question, I appreciate the additional color on Western and the institutional pipeline, but can you maybe just quantify the remaining legacy redemptions that you expect to come to an end this quarter and then any thoughts on the outlook for the global sovereign redemptions as well?

Mark Fetting

We worked hard on this, Mike, as you can see and I appreciate you noting that we have provided some incremental color. At this stage working closely with the team at Western, we don't see any significant and are not aware of any significant outflow like the two that we've referenced. One of which is ending and the other of which is probably so long as the current environment stays in shape, it might be somewhere in the neighborhood of $1 billion a month or so.

Here, again, what I am trying to also emphasize is the story of Western's progress is not measured by flows alone. Because of the shift in products and fees around those products, as you can see, our revenues aren't as impacted as those flows might suggest, the consultant activity, the sales activity and you can see most visibly right now the retail institutional fund activity going around globally.

Michael Kim - Sandler O' Neil

Second, after you get through the restructuring process and you get the 6% to 8% pop in margins, how should we be thinking about profitability from that point on? Is it reasonable to assume that you could get back to maybe the mid 30% range that you were running at in '06 and '07 just assuming equities and the retail channel are bigger pieces of your overall asset mix at that point?

Mark Fetting

Yeah. Let me build if I can the 6 to 8 points that we're confident in securing through the streamlining takes you up to about the 30 range. To go beyond that there should be an improvement in the mix towards equities and affiliates. You can see some of that now but there should be more, but you would have to have that and probably market to help as well to get into those mid-30s. So we're focused right now on nailing the 30 and then working to get that international equity alternatives piece moving in the right direction, etc.

Operator

Our next question comes from Michael Carrier of Deutsche Bank.

Michael Carrier - Deutsche Bank

Just one other question on the streamlining. When we started thinking about over the next two years but into 2012, the guidance that you guys gave in terms of the cost reduction is very helpful. So just when you think of the core business whether it's launching new products, just the growth in the markets and if we get, to say, mutual flows, just trying understand like maybe what a net number would be like, just the normal cost associated with running the business and maybe growing the business versus those streamlining benefits that you also get?

Mark Fetting

Let me tee it up and then Joe Sullivan is here, I might ask Joe to shed his thoughts as well.

The streamlining is designed to better position the company around cost that I think we haven't been handling as efficiently or as if in services that effectively. On a go-forward basis with that accomplished and the investments we've made in distribution, we think the company will get some operating leverage off of those two pieces. Now, to a certain extent, we're taking some of that operating leverage away because we're reducing the corporate spend in the shared service area.

Joe, you just might want to reinforce those thoughts.

Joseph Sullivan

Michael, the way we think about it is that we're going to see a meaningful reduction in our organizational or administrative costs. When the streamlining is complete, you'll see our administrative cost probably end up right round $115 million. I would say that's going to be down from about $250 million currently or when we began this process. So, you'll see, at the end of the day, our organizational/administrative cost around $115 million.

Michael Carrier - Deutsche Bank

Then just on the performance, it looks like long-term continue to see ongoing improvement there. Short-term, I think, for the industry has been under some pressure. It looks like the one year has fallen from like 81% to 44%. Just trying to gauge, you guys give that total and then some breakdown, just where is the most pressure on the short-term and is that weighing on any of the flows that we're seeing, particularly on the equity side of the business?

Mark Fetting

That one-year dip is principally in areas where we have our high conviction managers that are in the short-term not being rewarded for positions they think that will improve, capital management as an example, the value trust, opportunity trust, special strategies have given up some of the very performance they've delivered since the trough of March of '09. They remain very confident that in the near to medium term, their shareholders are going to be rewarded. So I would say that's where it's coming from.

Operator

Our next question comes from William Katz of Citi. Please go ahead.

William Katz - Citi

First question, just to come back to the legacy attrition, can you just specifically quantify the residual run-off , I understand it's $1 million a month, but can you just sort of to say what the residual AUM are for both, the sovereign wealth fund as well as the sub-advisory?

Mark Fetting

We haven't broken that out, Bill, but what you're seeing on that particular would be it's running around the 20% net outflow, which is higher than norm on a net basis, if I took a book of assets that the inflows are coming into that would be much more robust on the inside from coming in. Is that helpful?

William Katz - Citi

Not really.

Mark Fetting

Keep going then. What else?

William Katz - Citi

I really like to get to the absolute level so we could get a sense of where you stand in terms of how long the run-off is going to continue into fiscal 2011/'12?

Mark Fetting

In this stage what we're trying to say is, we are actually anticipating that in this particular situation we would see nothing that would change our view that you probably got to built in, at least for the foreseeable few quarters, $1 billion a month coming out of that one particular situation.

On the other hand, what we've tried to do, scrubbing the data as best we can at the sub-advisory, which was $1.3 billion this quarter we're right now reporting we'll end this quarter with another $1 billion. Beyond that it's kind of pluses and minuses. We really scrubbed this, Bill, and given you as much clarity as we see. Hence, it's really dependent as it should be on what is verifiable consultant rating improvements, sales activity improvements and the first visibility of that was in looking at just the global mutual fund data and the inflow that we're getting there.

William Katz - Citi

That extra point is very helpful. Second question, just about money markets in general. One is so in case you have mentioned the delta of fee waivers being $4 million this quarter. Could you just give us the absolute size?

Stepping back a little bit, the money market reform came out earlier, a late last week. Just sort of curious of your thoughts of how you sort of see the economics of the business going forward?

Mark Fetting

Yeah, what came out of the President's Working Group was certainly not unanticipated. As several have written does reinforce relative to regulation of that business things are fluid. I have been active in the Money Market Working Group and as a member of the Executive Committee of the ICI. We strongly believe in preserving the stable NAV. We do think this Liquidity Exchange Bank is a good option for regulators to consider under times of systemic risk, and we are actually gratified that they acknowledged that.

There is still more work to be done, but I remain hopeful that we will work through this in such a way that is one of the great services out there helping in America raise money and investors get the benefit of stable NAVs that what is now obviously low yield but should get higher as interest rates rise, remains a good business.

Terrence Murphy

For the absolute number, it's 26.5 for this quarter.

Operator

Our next question comes from Roger Freeman of Barclays Capital. Please go ahead.

Roger Freeman - Barclays Capital

Actually just to clarify on Western, I am a little bit confused. The two situations combined, how much are those running a month because you said $1 billion, but now it sounds like it's $1 billion on the sovereign piece and $1 billion on the sub-advisory. Is that right?

Mark Fetting

For the quarter, the two situations represent about $4.3 billion. $3 billion of that is the Global Sovereign Fund that we work within Asian client on and that will probably continue so long as market conditions remain the same in that market, at $3 billion a quarter, $1 billion a month.

What is ending is the other $1.3 billion this quarter. It will end with what we think is approximately $1 billion the current quarter 12/30 and that stops, it's over.

Roger Freeman - Barclays Capital

This is my second question, a follow-up to this. I don't know if you can say what Western total flows were, if you said that but if you just look at like your fixed income flows, those minus $8 billion in the quarter, most of that's Western. $4 billion of that is these two things, so there is another $4 billion. Then you said that the retail component, which is a third of the AUM, is positive. It sounds to me like there is still a decent chunk of negative, maybe $5 billion or $1 billion plus a month of sort of broad based outflows in Western. Is that a fair read?

Mark Fetting

Yeah, basically it's a smaller base. If you just started 8 and you take the full year down to 4, you add the 1, you're up to 5 and that 5 on a quarterly number is spread across a number of mandates both by asset class and by geography. We don't see any big chunk coming there in the current pipeline, but we wouldn't anticipate it, because it's across the whole global platform we're going to kind of work through it recognizing there is still some headwind there.

Operator

Our next question comes from Craig Siegenthaler of Credit Suisse. Please go ahead.

.

Craig Siegenthaler - Credit Suisse

You used to disclose a page in your slide deck on when will the streamlining occur. It looks like you identified $100 million of restructuring plus bridge one-time expenses in your fiscal year '11. I'm just wondering because so far the last three quarters you've only netted to about $30 million. Does that mean we have a big step-up in these one-time expenses in the March quarter or are you actually running below your previous guidance?

Joseph Sullivan

We're really running on track. It's just more timing than anything else. We're getting more of our charges are coming in towards the backend.

Craig Siegenthaler - Credit Suisse

Just a follow-up question on the money market issue. Now that money market funds are required to report daily NAVs, I'm wondering if you see any impact to your business. I may have missed it if you said it earlier. Some of your competitors like Schwab and T. Rowe have actually practically taking charges. Do you see any risks of that with your business?

Terrence Murphy

No, we've gone back and taken a look at all the money funds and there is no risk. There was one fund that may have been slightly under, but it's less than $1 million.

Operator

Our next question comes from Brennan Hawken of Collins Stewart. Please go ahead.

Brennan Hawken - Collins Stewart

It was a tick up this quarter and actually last quarter as well in the IA fee rate and you all highlighted a shift in Western with some of these flows going from lower fee to higher fee products. I'm wondering was that the primary driver? Was there something else behind that as well?

Mark Fetting

It's really spread across the book. Any growth in Permal can be very helpful on the fee side as they are probably our highest gross fee manager, and then we got some improvement in the equity mix and there was a reduction in the fee waiver. So all that contributes, as well as the piece you're talking about, but very importantly, the fixed income piece within Western.

Brennan Hawken - Collins Stewart

On the global sovereign, just a point of clarity, are you guys seeing the flows out of both the Limited Duration Fund as well as the Global Sovereign Fund that's US dollar hedged?

Mark Fetting

The Limited Duration products have continued to be a modest source of outflow. If you're talking about the legacy, what I'll call, cash plus business that's really declined to be a non-entity.

Operator

Our next question comes from Glenn Schorr of Nomura.

Glenn Schorr - Nomura

You gave us one but unfunded type for Permal and you mentioned that Batterymarch had a good pipeline. Do you have something on a more companywide basis that is won but not yet funded pipeline?

Mark Fetting

We don't have an aggregate number on that. I do know that Western, which continues to grow as their kind of improvement is literally a day-by-day thing certainly has several $1 billion of unfunded wins. So that's kind of improving nicely and that will continue to grow into the quarter as things gets nailed down in terms of timing of funding with some winning mandates.

Batterymarch has had some noted and, obviously, you mentioned what we did with Permal, the other ones become top of line.

Glenn Schorr - Nomura

The gains in the quarter on the corporate side, primarily seed investments, I'm not sure if I missed it, but can you tell us how large your seed portfolio is and what the unrealized loss gain position is today?

Terrence Murphy

The traditional seed investments currently are at $210 million and then we also have some investments in proprietary partnerships that total about $140 million. As far as the gain, I don't know that I have the absolute gain at my finger tips.

Mark Fetting

I will say kind of strategically, we actually talked about this at the board meeting. We had good discussions with some of our affiliates in our regularly scheduled meeting. We're going to look together on further hedging as appropriate. Right now, we probably hedge a quarter or so of what you characterize as traditional seed investments, where we have good data offsets. We're probably going to look to see if we can do some more there.

Operator

Our next question comes from Marc Irizarry of Goldman Sachs. Please go ahead.

Marc Irizarry - Goldman Sachs

Mark, just on Western, how much of your valuable annuity business, the sub-advisory business is up for annual review in the calendar fourth quarter?

Mark Fetting

As you probably know it's not automatically calendar driven. I would say the big issue there, Marc, and it's a big plus, is we have worked through a conclusion to some known outflows because of decisions made by those boards previously and now it's more about winning business. We're actually in front of opportunities there and the shift has turned.

Marc Irizarry - Goldman Sachs

Core, I guess, in global sovereign, products remain more than the third, (inaudible) more than third of Western's business. As you think about those two businesses in totality how much of the AUM in those products do you think is still at risk?

Mark Fetting

The global sovereign as just a standalone mandate in certain Asian markets is the source of some just current outflow which we've been talking about. That's not going to change until market conditions change. It remains an important client.

The core piece is, where the real activity around getting into finals. A year and a half ago, we were totally on the bench. Now we're in finals. We're winning some business. There are definitely some wins that we had above the several $100 million level in this current quarter and there are a lot more wins we're competing for in the finals this quarter.

So that one, Core Plus, which is about 20% or so of Western's total portfolio, is on the uptick, but the uptick still has some clients redeeming or reallocating in some cases because they are looking to just provide more manager diversity. In other cases, there is some allocation to quantitative that is being going on and that categories, obviously, are bit more susceptible. The big thing is we're going for new business now, not just spending time trying to retain what we got.

Operator

Our next question comes from Cynthia Mayer of Bank of America/Merrill Lynch. Please go ahead.

Cynthia Mayer - Bank of America/Merrill Lynch

On the performance fees, they were up year-over-year and I am wondering if the delta was driven mostly by Permal and what that implies for the December quarter?

Terrence Murphy

No, the performance fees for the quarter have been close to about $20 million or so for about three straight quarters. Now, Western had total fees of about $10 million, Brandywine had about $2 million, Permal also had about $8 million in performance fees for the quarter. What I would say is we're not going to move off of the target. We've previously communicated, it's about 10 to 20 per quarter and that's what I would expect.

Cynthia Mayer - Bank of America/Merrill Lynch

I apologize if you covered this, but which of the manager has accounted for the bulk of the $4 billion in equity outflows? You've mentioned Capital Management, ClearBridge and Batterymarch. Did anyone dominate? From what you see so far this quarter, are the equity outflows likely to subside or continue?

Mark Fetting

Cynthia, it was actually spread. There is no, certainly, no one dominated. ClearBridge being our largest equity manager was, in fact, the largest contributor, but their rate of outflow year-over-year declined nicely. Royce, this was the first quarter in a while where we had some modest outflows at Royce and some of that was certain platform programs making some allocations either out of small cap or into small cap quant.

On the other hand, let's say, current quarter, they are actually back getting into some inflows. So I think that's more of a noise I would say and the others were spread out.

Operator

Our next question comes from Macrae Sykes of Gabelli & Company.

Macrae Sykes - Gabelli & Company

Can you provide an update on the expected outflows from the liquidity relationship with Morgan Stanley? Assuming those flows had left this quarter, what would have been the impact on fee rate?

Mark Fetting

Yes. There has been no change in terms of the amount. We are talking about approximately $22 billion. The actual fee impact, bottom line impact to that business is negligible. There is a gross fee and then you've got to kind of work through all our haircuts. It gets down to less than $10 million pre-tax and even that's going to have some haircuts to it.

The key there, on the other hand, is that we've been working closely with Morgan Stanley Smith Barney on some other features in that business and we've made a lot of real progress. So when this piece is done which we think and it's really tied to just working through some systems issues for them, we think it's likely to be in April of '11, that's it.

We're really focused and Western's focused on growing the business across the board. They've actually made some nice progress within the Morgan Stanley Smith Barney system on some other arrangements that we work together on. Some nice progress in international clients who have come in. So we feel good about the progress we're making outside of this situation.

Operator

Our next question comes from Douglas Sipkin of Ticonderoga.

Douglas Sipkin - Ticonderoga

Just wanted to talk a little bit more just about asset allocation. Some of your competitors have talked about sort of an emerging concern for pensions and institutions about an ability to meet their obligations through bonds. Given where the level of interest rates are now, I mean are you picking that up from some of your clients who are potentially just looking to reallocate into equities from fixed income given sort of that backdrop?

Mark Fetting

This goes back to my opening comment about my visit to Asia, where I see and we'd all agree that the Sovereign Wealth Funds are emerging as some of the more sophisticated institutional clients in our business. They are clearly spending their time preparing to get back on growing their portfolio. They're still cautious. I remember one in particular; I was mentioning the article that Bill Miller did in the FT talking about large cap US equities paying more than 3% dividends. There has been never been a more compelling opportunity versus bonds since 1951. This particular client said, 'I totally agree. When do I pull the trigger? Just tell me when do I pull the trigger?' So they are prepared, but they're not yet doing it. They are preparing to do that.

In that regard, they are looking for us and our managers for more solutions-based approach than just traditional product. If you take a look at Western, we've launched an advisory service with some talented individuals that are making some real progress with clients. Permal is doing more solutions-based work with the institutional community and our equity managers are being asked to prepare for some strategies that are not off the shelf but customized to certain clients. Capital Management, as an example, won a nice mandate with a public fund client for such a situation.

Douglas Sipkin - Ticonderoga

Just digging into that and you gave a little bit of color, which equity managers do you believe are best positioned to capture some of that potential reallocation that may happen over the next year or so or two years?

Mark Fetting

Yeah, the large cap, the mid-cap managers are probably better positioned under the expectation that if you look at the last decade, kind of small cap as measured by Russell 2000 kind of 10 plus handled in large cap are flat. So this would favor ClearBridge, this would favor Capital Management. Batterymarch which is quantitative strategy under a more broadened market comes out of the box because quantitative managers in these inflection point markets always are a bit challenged and those are the ones I'd highlight.

Operator

Your last question comes from Jonathan Casteleyn of Susquehanna.

Jonathan Casteleyn - Susquehanna

Could you just go over your priorities for the cash balance? I know you talked about buying back $80 million in stocks in the forward quarter and you raised a dividend, but can you just talk about the remaining balance you want to keep on the financials for on operating basis, so we can understand what is excess cash?

Mark Fetting

Right now, we look at our excess cash position at about $700 million to $800 million. Our priorities would be to continue to support growth in the business and to extent there is an excess which clearly we've been doing more than certainly our longer term path, we're prepared to do the buyback and where it makes sense proportionate to earnings in cash generation to dividend.

At the same time, we're mindful of the rating agencies' support and hence, we want to do it consistent with what we've done. As we show improvement, there would be more comfort for us to pick up some of that buyback so long as we don't see other opportunities to grow the business.

Jonathan Casteleyn - Susquehanna

Quickly on the follow-up, do you have any qualitative feedbacks from the affiliates on the cost cutting? You've been very descriptive about what you expect the impact to be on margins and just the timing. Just curious, what sort of feedback you're getting from the efficiency standpoint from some of the affiliates?

Mark Fetting

We just through this quarter did a series of meetings with the affiliates, including getting all the affiliate heads together with myself and the executive team. They are very supportive of driving this through the completion. They have found, when they are taking on certain activities in this environment, a very good environment to get more custom-tailored functionality at significantly lower costs in bidding the stuff out. So, that's been a real plus.

At the margin always there is going to be some issues, which you've got to kind of work through and we're doing that. It gives us a lot of conviction that this is the right decision not just in terms of where we are doing it here in the US but also overseas. It's been a very good in constructive exercise.

I want to thank everyone for their interest in Legg Mason. We look forward to continuing to work hard. We're making progress. There is more work to be done and that's what we are going to do. Thank you.

Operator

Thank you, gentlemen. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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